A warranty is a promise from the product’s maker that the product will perform as promised. If it doesn’t, the manufacturer will fix it at no charge to the consumer.
The majority of warranties are restricted since they do not cover damage caused by accidents, abuse, or other non-defective issues.
Some manufacturers may offer additional assistance to help customers resolve their problems through technical support. This is most commonly provided for computer hardware, software, and electronics.
The length and amount of assistance vary among manufacturers, but a company generally offers 90 days of free phone support for troubleshooting a problem with their equipment.
After this period has expired, customers will have to pay a fee if they want to continue receiving phone support regarding the equipment.
Warranty liability is a future liability that the company must record and report since it is typically foreseeable and may be assessed relatively.
Similarly, based on previous experience, the company can generally calculate how high the warranty expense will be.
The warranty liability can be recorded by debiting the warranty expense account and crediting the warranty payable account in a journal entry. Following the matching principle of accounting, the warranty liability must be recognized when the firm makes the sale to guarantee that the warranty expense is aligned with the relevant sales income.
When consumers collect their warranties, the firm must enter a journal entry debiting the warranty payable account and crediting the warranty linked account (e.g., cash, inventory, repair parts, etc.).
Consider the company XYZ Ltd. has sold 15 products for $150,000 during September, including a five-year warranty for repairs. Based on experience, the average cost of the repairs over the warranty period is estimated to be 10% of the sale price.
In this case, the company XYZ Ltd. can record warranty liability of $15,000 (150,000 x 10%) in the September 31 adjusting entry with the below journal entry:
If this journal entry is not made in the January period, both total liabilities on the balance sheet and costs on the income statement will be underestimated by $8,000.
Later, when the company provides the repairs under warranty for its customers, it can make the journal entry by the debit of warranty payable and the credit of repair parts.
When a corporation sells a product with a warranty, the warranty should be paid for a purchase. There is no right or incorrect method for calculating the possible responsibility of providing a warranty. Assume Khai Ventures anticipated a $500,000 potential liability due to previous sales.
The Khai Ventures would debit warranty expense and credit accumulated warranty, which is a liability on the balance sheet, to record the liability. The goal of this is to record the warranty cost while the revenue is recognized.
Expected warranty claims:
The company would subtract accruing warranty liabilities and credit cash when a client actually submits a warranty claim, which may be a year or two later.
When claims are paid:
When a firm sells a product with a guarantee, the company is obligated to fix or replace it if it is defective. Because the corporation has a duty that begins when the product is sold, that obligation establishes a liability when the product is sold.
Following are the benefits of warranty liability for manufacturers:
- Offering Warranty Liability to your customers is an intelligent way to earn their trust and loyalty. When you offer warranties on products, you’re telling your customers that they can rely on your company and that you believe in the quality of the products you sell.
- You’re also showing that you stand behind your products and want customers to be happy with them.
- Customers who receive a warranty from your company are reassured that they can return something if it doesn’t work correctly or is defective. In this way, warranties build trust between the customer and your business.
- It shows that you care about the satisfaction of your customers, and you want them to know that. Should something fail, the customer knows that they won’t be out money for a product that didn’t work correctly.
- It also shows confidence in the manufacturing of the product. If a manufacturer believes in their product enough to warrant it for X number of years, then consumers are likely more confident in purchasing it.
If you’re a business owner, you can take advantage of a little-known benefit that may save you money in the long run: warranty liability. Although many companies have no idea that it exists, it has the potential to be extremely helpful for those looking to lower costs without sacrificing quality.
To understand what we mean by “warranty liability,” first recall the last time you bought something with a warranty on it. You probably saw that the company offering the warranty said they would repair or replace your item if anything were to go wrong within a certain amount of time after purchase.
If you’ve ever needed to use your warranty, you know what a relief it is—and certainly worth the cost of having spent extra money on it when you bought your product. When companies offer warranties, they’re also making themselves liable for any future damages incurred by their products.